Michael B. O'Higgins' 1991 concept of the Dogs of the Dow is a popular investment strategy. In this article, I am looking for the real bad dogs, those stocks that as a group perform better than the whole.
The Dogs of the Dow for a year are identified as the 10 stocks in the Dow Jones Industrial Average [DJIA] index that have the highest dividend yields. These stocks collectively have greater returns than the Dow Jones Industrial Average. The strength of this strategy lies in the ease of identification of the stocks.
Issues with the strategy of Dogs of the Dow
When I analyzed the list of the stocks comprising the Dogs of the Dow since the last decade, I observed something interesting. The list has changed over the years. Some stocks have been excluded, while some are not consistent in their presence. The interesting thing to note is that some stocks are present on the list for all the years. I therefore came up with the concept of the "Stray Dogs of the Dow". The Stray Dogs are the Dogs which are on the list consecutively for many years, just like the stray dogs of the street which never leave the locality. These stray dogs never leave their place for their whole lifetime. Similarly, on Wall Street, Stray Dogs are those stocks on the Dogs of the Dow list which have been present on the list for many years.
Identification of the Stray Dogs
The Stray Dogs can be identified by analyzing the list of the Dogs of the Dow for the past decade, as shown below.
As can be seen from the table above, not all of the stocks are present in all the years. DuPont (NYSE:DD) is the only stock which is present on the list for all the years since 2003. The other stocks which have been present on the list mostly with exception of a couple of years are AT&T (NYSE:T), Verizon (NYSE:VZ), Merck (NYSE:MRK) and Pfizer (NYSE:PFE). These stocks are the Stray Dogs of the Dow for the last ten years.
The one special reason for choosing them from the list of the Dogs is their relative consistency. Like I showed in my previous article from October, and as shown in the chart above, you can see that these 5 stocks were consistent with their dividends, year after year. That is unlike the other stocks in there, which would move in and out of the dividend payers' list.
Advantages over the Dogs
The most important advantage is that the portfolio of the Stray Dogs gives a better return than the portfolio of the stocks of the Dogs of the Dow. I will explain it later in the article. The total return of the Dogs is due to the combined performance of all the 10 stocks but there are some stocks whose performance is less than the other stocks. The principle of averages used while calculating the yield of the Dogs of the Dow lowers the returns. Hence, there is a better investment strategy than the Dogs. The Stray Dogs of the Dow is that strategy and it retains the benefit of ease of identification as used in the Dogs of the Dow.
Some of the other advantages related to Stray Dogs are that these stocks have a history of yielding good dividends and they will continue to do so in the future. These stocks are a buy for the long term. Hence, they also reduce cost in terms of less brokerage charges involved.
Performance Analysis of the Stray Dogs
I have analyzed the performance of the 5 stocks included in the Stray Dogs of Dow for the year 2012. The analysis is done by investing the same amount in all the stocks. Final value for a stock is the value achieved by adding the value of the initial investment at the end of the year and the total dividends paid in the year.
As seen from the above table, Pfizer has the maximum total returns of 19.94% for the year 2012. The most important thing to observe is that the total yield of the portfolio of the 5 Stray Dogs is 13%, and is much better than the 7.3% yield of DJIA for 2012. Four out of the five stocks beat the DJIA for 2012, with returning a better yield than the yield of DJIA. AT&T has provided the maximum dividend and a great total yield of 17.28%.
A great insight from the table above is that the portfolio of the Stray Dogs is well diversified with some of the best stocks of the telecom and healthcare sector. This diversification reduces the risk associated with the portfolio to a great extent.
Comparison of various investment strategies:
Total return in 2012
Stray Dogs of Dow
Dogs of Dow
I have compared the three investment strategies of Stray Dogs of Dow, DJIA and Dogs of Dow in terms of the total returns offered in 2012. The strategy of Stray Dogs of the Dow has the maximum total returns. As I have mentioned above, the strategy of Stray Dogs of Dow has better returns than the strategy of Dogs of Dow. It can be validated from the table above. The total return of 13% for Stray Dogs of Dow is more than the return of 9.8% for Dogs of Dow for the year 2012. In my best west of downtown Chicago brogue, I will call these the real bad dogs of dividend investment.